Accounting For Stock: What Is Cost Of Goods Sold And Methodology ( Part 2)

WHAT IS COST OF GOODS SOLD?

 

In Part 1, we understood what is stock and what stock stand for. These stock-in-trade or inventories are purchases of goods by a business for resale to the customers with the intention of earning a profit in the process.

On the other hand, cost of goods sold is an expense line in the Income Statement. It is that portion of the cost of stocks that have been consumed/delivered to the customers so as to generate the necessary revenue for the business.

The matching concept, dictates that we need to match the portion of costs of stock consumed against the revenue that has been generated.

 

HOW MANY WAYS OF COMPUTING COST OF GOODS SOLD?

Basically, there are two(2) methods of computing Cost of Goods Sold.

Method No 1 : Cost of Goods Sold in PERPETUAL STOCK SYSTEM:

This method is called the perpetual stock system which is usually used by businesses selling goods that have a high individual unit value such as cars, furniture, electric motors, electrical appliances.

 

The perpetual stock system is relatively easy way to maintain records of the cost of each unit of goods  hence is easy to compute the cost of each unit sold

Illustration of Perpetual Stock System:

Say, a enterprise has bought 2 identical units of motor vehicle at a cost of $50,000 each.

Subsequently, the enterprise sold off 1 unit for $80,000.

 

Double entry as follows:

To record purchases of stock:

Debit: Stock                                         $100,000

Credit:  Creditors/Accounts Payable                    $100,000

Being purchase of 2 units of motor vehicle at $50,000 each

 

 

To record sale of stock:

Debit : Trade Debtors/Accounts Receivable   $80,000

Credit: Sales                                                                $80,000

Being credit sale of 1 unit of motor vehicle

 

Debit: Cost of Goods Sold                              $50,000

Credit: Stock/Inventory                                                $50,000

Being cost of motor vehicle sold

 

 

In The Income Statement:

Sales                                        $80,000

Less:

Cost of goods sold                  ($50,000)

Gross Profit                              $30,000

 

The second method is :

Method No 2 : Cost of Goods Sold in PERIODIC STOCK SYSTEM:

This method is called the periodic stock system which is usually used by businesses selling goods that have a very low value per unit value such as stationery, consumer goods and others.

 

The periodic stock system is chosen rather than the perpetual stock system as the business finds it to cumbersome or finds that the extra cost of record keeping under the perpetual system more than outweighs the benefits derived. Close control is deemed unnecessary or uneconomical.

Illustration of Accounting Under Periodic Stock System:

The stock account is not adjusted after each purchase or sale.

Adjustment is made only at the END of the accounting period when preparing the Income Statement. At the end of the accounting period, there is a physical stock count being conducted and there is no account balance against which the physical count can be checked. The stock account does not show the cost of goods that should be on hand.

 

Unlike the perpetual system where each sale is traced specifically to that particular unit of stock purchased, there is no attempt to determine the cost of goods sold for each sale at the time of the sale.  The cost of goods sold for all of the sales in a period is determined at the end of the period and we need to know the following:

 

Costs of goods on hand at the beginning of the period (opening stock)

Costs of goods purchased during that period ( purchases) and

Costs of UNSOLD goods on hand at the end of the period ( closing stock)

The formula is simple and computed as follows:

Opening Stock + Purchases- Closing Stock = Costs of Goods Sold for the Period

 

 

In the Income Statement:

Opening Stock                                     $50,000

Add: Purchases                                    $30,000

Cost of goods available for sale          $80,000

Less: Closing Stock                             $ 60,000

Cost of Goods Sold                             $20,000

Interpretation:

We have the business started the period with $50,000 of stock on hand and further purchased $30,000 of goods during the same period. Total costs of goods available will be $80,000 ready for sale during the period. At the end of the period, $60,000 of the cost of goods was actually sold during the  period assuming no goods were damaged or stolen.